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Tuesday, 25 October 2016

What might Brexit mean for UK manufacturing?

The question of how UK
manufacturing will fare post-Brexit is often presented in the somewhat
simplified terms of a transactional relationship between UK manufacturers and
EU markets. ‘Leavers’ contend that because the EU sells more goods to the UK
than the UK sells to it, we will have the upper hand in negotiations. But
that position overlooks the nature of modern manufacturing, which today relies
on complex networks of companies, scattered across the globe, all dependent on
each other to produce finished goods and services.

In order to unpick how much
UK manufacturing depends on access to the EU Single Market we need to consider
the issue from three different but connected perspectives: the manufacturing
trade environment, the impact on foreign direct investment, and the importance
of manufacturing value chains and networks.

In terms of trade, the UK
has run a deficit since 1998, largely caused by a deficit in traded goods.
According to the Office of National Statistics, the 2015 deficit was around
6.9% of GDP, although this is partly offset by a surplus in services, resulting
in a balance of -2.1% of GDP. Clearly the devaluation of the pound in the
immediate aftermath of the EU referendum may have a positive impact on exports
- UK exports are currently around 20% cheaper than they were pre-referendum - which
makes UK goods more affordable and appealing to international markets. However,
the impact of this devaluation is likely to be short-lived. Already there is
evidence of inflationary pressure affecting imports used by UK manufacturers.
As price increases flow through supply chains, the cost of finished goods will
also increase, offsetting competitive advantage gained through a weak pound. In
the long term, the way to address the UK’s deficit is through trade - ensuring
that we export more than we import - and for that we require access to
international markets, both in Europe and beyond.

In recent years, the UK has
been very good at securing foreign direct investment, but the Japanese
Government, in its letter to the United Kingdom and European Union, challenged
any assumptions that this would continue untroubled by Brexit. The letter,
delivered just before the G20 meeting, was remarkably explicit, raising five
substantive issues that would deter future investment: uncertain trading
conditions, additional customs duties, inability to access services and make
financial transactions seamlessly across Europe, inability to access workforces
with the right skills, and the need to deal with different sets of regulations
and standards in the UK and the EU. The Japanese Government’s warning was
stark: “Japanese businesses with their European headquarters in the UK may
decide to transfer their head-office function to continental Europe if EU laws
cease to be applicable in the UK after its withdrawal”.

As commentators have noted,
the Japanese letter makes it clear that the UK is not just negotiating with the
EU over Brexit, but it also has to strike a deal that satisfies the
requirements of other international trade partners. Failure to do so will
isolate the UK further from the international community and runs the risk that
future foreign direct investment will be more difficult to secure.

The third issue is that of
global supply chains. Today’s manufacturers do not operate within the
boundaries of a single country. To describe a manufacturer as British –
in competition with, say, its US or German or Japanese counterparts – is
somewhat misleading. Competition in modern manufacturing takes place
between interdependent groups of firms, often from different countries, that
share knowledge and collaborate with one another to produce goods and deliver
services. Raw materials are typically sourced in one location, intermediate
inputs (such as parts and components) are produced in another and then exported
somewhere else for further processing and/or assembly into final products. And
it’s not just supply chains that function across boundaries: the
knowledge-intensive aspects of manufacturing such as R&D, design and
professional services are similarly geographically dispersed.

For manufacturers to be
competitive they need access to high quality production ‘inputs’. These inputs
include not only components, systems and specialised services but also workers,
finance and even infrastructure, many of which are imported from abroad. Data
from the OECD shows that a considerable proportion of UK exports rely on UK
manufacturers first bringing in inputs from abroad, processing them and then
exporting them. In 2011 the content of UK exports that had been
previously imported was around 23%, and that figure appears to be higher than
for the other major EU manufacturing economies.

Conversely, over half
(52.5%) of UK manufacturing domestic value added is driven by foreign final
demand, and a significant proportion of what the UK exports are not final
goods, but products and services that are further processed by another country
before reaching the consumer. Of the UK’s total exports of domestic value-added
in 2011, 63.7% were not final goods.

So the picture complex. The
assumption that the balance of trade deficit strengthens the UK's hand in
Brexit negotiations only holds if the factories using these imports are
confined to the UK. If the tariffs on importing intermediate goods become too
high, however, there may come a tipping point where it might be more
competitive to move some activities (and factories) to the EU.

While uncertainty remains
over what Brexit actually means, it is clear that the impact on manufacturing
will be significant. For manufacturing to thrive and prosper we need an
agreement with the EU that is open, transparent and enables international
trade, investment and knowledge to flow with ease. Anything less runs the risk
of damaging the long-term health of UK manufacturing.

Professor Andy Neely, Head
Institute for Manufacturing, University of Cambridge.Dr. Carlos López-Gómez,
Head of Knowledge Exchange, Policy Links, Centre for Science, Technology &
Innovation Policy (CSTI), University of Cambridge.

2 comments:

The failure to sign the CETA deal with Canada highlights that the EU is ill-equipped to open up trading opportunities to the fastest-growing and/or largest economies in the world.

While not downplaying the pain of unhitching ourselves from the current trading status quo with the Single Market, the increased (post-Brexit) likelihood of signing trade deals with 355 million North Americans, 30 million ANZ, adding an India here and an ASEAN there - this is where the real opportunities lie in the 21st century.

And of course ... all of the above should in theory continue to be possible with a bespoke British trade deal with the EU which will *at least* be equivalent to CETA, and would probably be superior.

Could Canada succeed with WTO rules access to the US, unlikely. What the failure of CETA deal highlights is that to get a deal with the closest and largest trading partner, with whom we currently have a the freest possible arrangement, will be almost impossible.

All very well to trade with the rest of the world but if the door is shut on the closest (and both time and shipping costs do matter in manufacturing) and largest partner then UK manufacturing will be in a position where the savings in input costs (paid for by inflation eroding the income and wealth of wage earners) are wasted on logistics and tariffs costs. Given the UK's negotiating position the new trade deals are highly unlikely to be favourable compared to the existing deals the EU has. Add to that the glacial speed with which these deals occur and we have a huge period 8 - 20 years while we negotiate our position in which much investment in building export markets is at unnecessary risk.

About Me

Pro-Vice-Chancellor: Enterprise and Business Relations and former Head of the Institute for Manufacturing at Cambridge University. Founding Director of the Cambridge Service Alliance. Specialising in manufacturing and services, especially strategy and performance, business models and analytics.